Startups Scramble to Define 'Employee'

By Greg Bensinger Hundreds of startups that rely on freelancers to clean houses, run errands, deliver food and ferry people are under siege.Lawsuits are threatening to reclassify their contractors as employees, which could drive up labor costs an estimated 20% to 40%. That has put an investment chill over these startups and prompted some founders to switch their business models.The latest is Luxe Valet Inc., an urban car-parking service, which says it plans to convert hundreds of parking attendants across seven U.S. cities to employees—and give them the option of setting part-time or full-time schedules. Luxe will pay for expenses such as cellphones, uniforms and scooters, plus health benefits to those who work full-time. Co-founder and Chief Executive Curtis Lee said Luxe will have greater control over its valet drivers’ training regimen and schedules. “We believe from a long-term basis this is going to be beneficial to us,” he said.The leaders of other companies privately say they fear regulators will eventually force them to shift to a part-time or full-time workforce. Delivery startups Shyp Inc. and Instacart Inc. have already laid plans to switch.In the biggest jolt to date, housecleaning service Homejoy Inc. said it will shut down on Friday, in part because four lawsuits hurt the company’s chances of raising more money. Homejoy previously had raised about $40 million from prominent venture-capital firms.Some venture capitalists say they are retreating from contractor-driven startups. “We’re definitely pumping the breaks right now,” said Tim Young, a general partner at Eniac Ventures, which has invested in Luxe. Mr. Young said the sudden failure of Homejoy may ripple through Silicon Valley and said he’s turned away some startups in part due to labor concerns.A shakeout of on-demand startups could undermine one of the primary engines of skyrocketing tech valuations. In the past five years, this group of mobile apps, led by car-hailing service Uber Technologies Inc., has collected about $11.4 billion in venture capital across 283 deals, according to data tracker CB Insights.In late 2013, Homejoy founders and sibling coders Adora and Aaron Cheung seemed to go from rags to riches thanks to $38 million invested by Google Ventures, Andreessen Horowitz and others. By this year, the San Francisco company offered $25-an-hour housecleaners in five countries, expanded into home repairs and carpet cleaning, and hired actor David Hasselhoff to star in a commercial.But after burning through much of that cash, Homejoy couldn’t raise new funds amid lawsuits claiming it misclassified its roughly 1,000 workers as contractors. Homejoy declined to comment.“Many of these companies operate on very thin margins—not all can absorb the hit of having to switch to an employee workforce,” said Jamie Davidson, a partner at Redpoint Ventures, which has invested in Homejoy and Luxe. “There is a real regulatory risk here, which we have to weigh, that some of these companies could owe millions in back wages and taxes.”Entrepreneurs and venture capitalists alike developed a fondness for “1099 workers,” referring to the tax form they file, because they don’t require costly outlays such as health insurance, payroll taxes, travel reimbursement, training programs or severance pay. Uber, and dozens of other on-demand companies, argue that it simply runs a smartphone app that matches people with freelancers. And besides, Uber says, its drivers like the flexibility to work whenever they want without a boss directing them.While there are no definitive statistics around the number of workers involved in the on-demand economy, consulting firm MBO Partners estimated 17.9 million people worked in 2014 as independents for 15 hours or more a week.Uber, with more than 200,000 contract drivers and a valuation approaching $50 billion, has become the touchstone of the 1099 debate. Last month a federal judge allowed lawsuits by two drivers to proceed in court, and California’s labor commissioner recently ruled that the San Francisco company should have classified a driver as an employee, and required Uber to pay back wages.The labor commissioner found that Uber controls major aspects of its operations—such as vetting drivers and setting rates for trip fares—so its drivers in California should qualify for minimum wage, overtime and workers’ compensation.Several other companies, including Uber’s rival Lyft Inc. and delivery companies Instacart and Postmates Inc., face similar suits and plan to defend against them. While these specific cases may take years to play out, momentum from litigation, —including similar suits leveled at FedEx Corp., is putting Silicon Valley on edge.The lower cost of contractors is crucial to young companies getting started. Upsetting that balance, investors say, could discourage other entrepreneurs from founding new startups.“If you have 1099s and you have to raise money in the next 12 months, you’re going to be in a precarious position,” said Roger Lee, a general partner with Battery Ventures, an investor in prepared-food delivery company Sprig Inc., which uses contractor drivers, after starting out with employees.Many companies are standing their ground. Daphne Carmeli, the CEO of Deliv Inc., which delivers merchandise from stores to customers’ homes, said she takes pains to ensure she doesn’t trigger a reclassification of her contractor workforce. Drivers don’t wear Deliv T-shirts, for instance. But she said her Menlo Park, Calif., company has a contingency plan. Though she declined to provide specifics, such plans generally involve using fewer people or lowering wages. Other startups aren’t waiting around. Shyp, which dispatches workers to collect customers’ goods and mail them, will by early next year employ its hundreds of 1099 workers in its hometown of San Francisco, as well as New York and other cities, making them eligible for health care, workers’ compensation and vehicle expenses.“It’s no secret it’s more expensive,” said Shyp CEO Kevin Gibbon. However, he said, Shyp would gain efficiency by being able to train employees, schedule them, review their performance and designate which jobs they must accept.Grocery-delivery firm Instacart is also switching some of its workers to part-time, though with more limited benefits. The San Francisco-based company said only those who remain in a grocery store for their shifts, plucking items from shelves for customers, are eligible for the change. Drivers delivering those items will remain contractors.Luxe, Shyp and Instacart maintain the changes weren’t prompted by lawsuits or the Uber case.Others like prepared-food deliverer Munchery Inc. and personal-assistant service Alfred Club Inc., have long employed their workers, viewing it as a recruiting and scheduling advantage. “It became much easier to expect them to show up on holidays or Sundays,” said Kris Frederickson, Munchery’s operations vice president. Marcela Sapone, CEO of New York-based Alfred Club, which goes by Hello Alfred, estimates her household-task company pays at least 20% more on labor costs than when the company had contractors in its early days. Silicon Valley venture capitalists were reluctant to invest in her company over concerns about costs and whether Hello Alfred could expand quickly into new geographic markets without contractors, she said.“They thought we were silly,” she said, adding that Alfred ended up raising about $13 million from East Coast investors. For its part, Munchery has raised about $125 million, including from Bay Area-based firms.Handy Technologies Inc., an on-demand home-services provider, sought in its user terms of service to pass along workforce liabilities to its customers. If Handy was found liable for any back taxes on its workforce, the provision read, the customers “will immediately reimburse and pay to an equivalent amount, including any interest or penalties.”After an inquiry from The Wall Street Journal, Handy removed the provision. A spokesman said the provision “doesn’t reflect the way we do business” and that it was inserted in error.Like others, Handy CEO Oisin Hanrahan said that if his company chose or was compelled to employ its workers, Handy would likely raise its rates and lower the average hourly pay, which he said is about $17 today. “We’d get closer to minimum wage,” he said. Write to Greg Bensinger at

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